6 rules for loaning money to a family member

Our families can demand a lot from us. Naturally, they expect love, attention, and support. But sometimes, they also ask for things that are far more tangible, like money.

Loaning a relative money with the expectation to be repaid can be an awkward situation, especially if you’re not sure how to approach it — Do I make them sign a contract? Should we establish a repayment schedule? What if they never repay me?

To answer these questions (and more), Business Insider consulted two financial planners. Both cautioned against loaning money to family, but if you’re considering it, here are six rules they recommend following.

Put everything in writing.

“Put the parameters in place — time frame, interest rate, and when payments need to start,” says Mary Beth Storjohann, a certified financial planner and CEO and founder of Workable Wealth. “I think getting it in writing makes it more tangible, but still with family, you have to be willing to enforce that.”

She added that it’s important to have a conversation about what will happen if payments are missed.

Alan Moore, a certified financial planner and cofounder of the XY Planning Network, even suggests putting together a legal contract involving an attorney.

“Treat this as you would any other loan,” he said. Don’t leave anything out and don’t make any assumptions, Moore said.

Determine an interest rate for repayment.

Storjohann suggests consulting the IRS-approved interest rates for family loans above $14,000, the annual limit on tax-free gifts. That currently amounts to 0.66% for “short-term” loans of up to three years, 1.29% for “mid-term” loans from three to nine years, and 1.95% for “long-term” loans over nine years. These rates will help you avoid unnecessary tax complications — for instance, the IRS could charge you taxes for the interest you could have collected, even if you didn’t — and hold your borrower accountable.

Consider what will happen if they don’t pay you back.

Storjohann asks: If you see your family member taking vacations or making frivolous purchases, but failing to make loan payments, how will you feel and how will you handle it?

Ideally, you should have an open and honest conversation early on about what will happen in the event that the terms you agreed upon aren’t met, according to Moore.

“All parties need to be aware of the consequences should that happen, so it isn’t a surprise,” Moore says.

Know that your relationship will change.

Money is often a divisive and awkward topic, especially in personal relationships.

“Loaning money to family members is more than just a financial decision — it’s also an emotional one,” Moore says. “Loaning money to someone across the Thanksgiving table from you can cause major issues, sometimes without you realising it.”

“It turns your relationships from sibling to lender, and when there is an issue (or even if there is not), it can make you seem like you’re holding the money over them even when you don’t intend to,” he said, advising that it’s imperative not to mention the payments outside of predetermined times. “Even off-hand comments across the room like, ‘Sure hoping to get that first payment soon!’ can ruin a relationship.”

Learn how to say no respectfully.

Just because someone you love is asking for money doesn’t mean you have to comply. Whether you genuinely don’t have the cash to loan, or you’re just avoiding a potentially sticky situation, Storjohann offers advice for rejecting a family member’s request:

“I think the biggest thing is to say, ‘I understand the place you’re coming from, but I have personal family financial goals that we’re working toward right now, and I want to make sure I’m on track for those, and unfortunately there isn’t any extra wiggle room to make these things happen.'”

Make it a gift instead.

Both Storjohann and Moore ultimately advise gifting money rather than loaning it, if you can afford it. You can even call it a “pay it forward” gift, Moore says.

“Tell them you are giving them the money knowing they need it, but that you don’t want to sour your relationship over it,” he said. “Tell them the terms of the loan are [that] they gift the same amount to someone else in need.”